TREASURIES-U.S. bonds rally as debt deal seen temporary respite

October 17, 2013

* U.S. debt deal seen stop-gap and this may weigh on economy

* Short-term bill market rallies as default averted

* Long-term bonds firm as business confidence may take a hit

* Fed may also delay plans to reduce stimulus

By Marius Zaharia

LONDON, Oct 17 (Reuters) - U.S. Treasuries rallied in Europe on Thursday after a deal to avoid a U.S. default was seen as a stop-gap, sparking long-term growth concerns that could delay Federal Reserve plans to reduce bond-buying stimulus.

A last-minute deal to lift the U.S. debt limit paved the way for the U.S. government to re-open after more than two weeks, but it only secured funding until Jan. 15, raising the likelihood of another round of political brinkmanship.

The fact the agreement left unresolved fundamental issues of spending and deficits brought only short-term relief and raised long-term worries that the debt ceiling would become a structural drag on the economy.

This in turn was likely also to delay plans by the Federal Reserve to trim its vast bond purchase programme, giving an extra boost to Treasuries, analysts said.

With the risk of a near-term historic default averted, October T-bill yields fell by more than two thirds to 0.21 percent.

The impact on investor appetite for risky assets, however, was limited and longer-dated paper, seen as a safe-haven even during the budget deadlock, also rallied. Ten-year U.S. T-note yields fell 5 bps to 2.62 percent, while T-note futures rose 12/32 to 126-41/64.

"The nature of the deal disappointed because we're going to see this game happening all over again next year," Rabobank strategist Philip Marey said. "It casts dark clouds over the economy - politics are now the main drag for growth in the U.S."

Expressing similar concerns, Chinese rating agency Dagong downgraded the United States to A- from A and maintained a negative outlook on the rating. Its ratings are hardly followed outside China and the change did not move markets.

The deal is likely to release a flood of economic data that has been delayed by the government shutdown.

"It's back to fundamentals now," Investec chief economist Philip Shaw said.

"First, there's been a slowdown in the economy in the fourth quarter; second, the pause in economic data during the government shutdown failed to give a more complete picture of what's going on; and third, it's possible that we go through this once again in January."

While most T-bill yields retreated, those of bills maturing in February remained near their highest levels since they were issued. They were last quoted at 0.10 percent, having hit a high of 0.14 percent on Wednesday.

"Over the course of January we're going to see the same thing happening to bills maturing around that date that we've seen with October T-bills," Rabobank's Marey said.